Latest Stories

LIFO Snafu Is Change in Method

The Sixth Circuit Court of Appeals recently
upheld a Tax Court finding that the consistent
omission of a step when computing inventory cost under
the dollar-value LIFO method was a change in
accounting method rather than a mathematical error.
Thus a $1,754,293 cumulative difference between the
correct valuation of inventory and the taxpayer’s
computed amount at the beginning of the first year
under examination was included in that year’s income
under IRC § 481.

Taxpayers have some latitude
when choosing an accounting method as long as the
method clearly reflects income. An accounting method
includes the treatment of a specific item as well as
an overall method. According to Treasury Regulations,
a change in accounting method includes a change in the
treatment of an item that affects its proper timing as
a deduction or inclusion in income but excludes a
mathematical error, posting error or an error in the
computation of tax. In the year a taxpayer’s
accounting method is changed, IRC § 481 requires an
adjustment to that year’s taxable income to prevent
the duplication or omission of income or deductions
due to the change.

The Huffman Group is
composed of four S corporations, each of which is an
automobile dealership in the Louisville, Ky., area.
Two of the car dealerships began using the
dollar-value link-chain method for valuing their
inventory in 1979, while the other two started using
it in 1989. Whenever an inventory increment was added
in a year, Huffman’s accountant valued the newly added
layer at the base year prices, failing to multiply the
layer by the current year’s price index. Thus, the
accountant understated ending inventory, overstated
cost of goods sold and understated taxable income.
Upon examination, the IRS increased taxable income for
each open tax year for all four dealerships by
$924,479, which the taxpayer agreed with. The IRS also
applied section 481 and increased the first open tax
year’s taxable income by $1,754,293—the difference
between the inventory amount as adjusted by the IRS
and the dealerships’ reported inventory amount at the
beginning of the first open tax year. The taxpayers
disagreed with this adjustment and asked the Tax Court
for relief, arguing that they had not changed
accounting methods but instead had made a mathematical
error. The Tax Court held in favor of the IRS, stating
that mathematical errors are errors in addition,
subtraction, multiplication and division, not the
omission of a critical step. The Huffman Group members
appealed the decision to the Sixth Circuit.

The Sixth Circuit agreed with the Tax Court but
chose not to opine about its definition of
mathematical errors. Instead, the court held the
change met the regulations’ requirements as a change
in method because the continued use of the taxpayer’s
method would only have deferred, not permanently
excluded, income. The lower inventory valuation would
result in higher future income when the inventory was
liquidated. It also noted that Huffman’s situation was
similar to an example in the regulations illustrating
a corrective change in method. In Treas. Reg. §
1.446-1(e)(2)(iii), Example 6, properly including
overhead costs in inventory valuation after those
costs had consistently been omitted is given as an
illustration of a change in accounting method.

This case illustrates that a change in accounting
method for tax purposes is a broader concept than for
financial accounting purposes. Under FASB Statement
no. 154, Accounting Changes and Error Corrections
, the Huffman Group’s change would be a mistake
in the application of GAAP and thus an accounting
error, not a change in accounting principle.

Huffman v. Comm., 101 AFTR2d
2008-1078

Prepared by Charles J. Reichert ,
CPA, professor of accounting, University of
Wisconsin–Superior.

TAX NEWS

President Barack Obama signed legislation that retroactively extended more than 50 expired tax provisions for 2014, allowing taxpayers to take advantage of a host of tax incentives during this filing season.

A weekly snapshot of global accounting with news from the Journal of Accountancy and other leading accounting publications. It includes summaries of what matters to you, written by expert editors to save you time and keep you informed and prepared.